BMW produced its first car in its $250 million Araquari facility on September 30. (Photo: BMW)

Monday, October 20, 2014

Special Reports

Brazil Autos: Down, But Not Out

Brazil's auto demand is forecast to continue to climb, with the market exceeding 5 million units from the mid-2020s.

BY
NEIL KING

Light vehicle sales in
Brazil rose every year from 2004 to 2011 but faced with weak economic growth
and flagging car sales, the government lowered the tax on industrial products
(IPI) on May 24 2012 in order to stimulate demand for new cars. The reduction
was originally planned to run until August 31 but was extended and the end
result was that sales of light vehicles increased by 6.1 percent in 2012 even
though GDP growth for the year was a lackluster 1 percent. This lowered IPI
rate was further extended and was actually in effect for the whole of 2013 but
with demand already pulled forward into 2012 and GDP growth at an improved but
still modest 2.5 percent, the measure was insufficient to prevent light vehicle
sales in Brazil falling by 1.5 percent year-on-year. This was the first annual
decline the market had endured since 2003 and the outlook for 2014 was not
looking any better.

Despite this, the
Brazilian government planned to return the IPI rate to the level prior to
the reduction that was introduced in May 2012 in two steps. The first hike was
in January 2014 and the second was scheduled for July, with the net effect
being that, from July onwards, cars would essentially cost 7 percent more
than in 2013. Nevertheless, sales started the year off well, increasing by 1
percent and 10.5 percent in January and February respectively as vehicles were
still being registered that had taken advantage of the reduced IPI rate.
However, the inevitable downturn materialized in March and demand contracted by
7.3 percent in the first half of the year. Given this and
the economic weakness in 2014, the government decided on 30 June to
postpone the second tax hike until January 2015.

Acting as a further
impediment to demand in 2014, Brazil's government also introduced legislation
in January which requires that all cars are fitted with air bags and anti-lock
brakes as standard. This naturally means that certain models are no longer
available and in turn, has a negative impact on sales. Finally, to confuse
matters further, IPI is levied at a minimum of 30 percent on cars imported from
outside Mexico and the Mercosur region as the government seeks to protect the
domestic automotive industry by curtailing the flood of imports. The import tax
has certainly had the desired effect, with imports accounting for 18 percent of
all registrations thus far in 2014 - compared to 24 percent in 2011 for
example. In line with increasing IPI rates for locally-produced vehicles,
the rates for imported cars have also increased. The table below provides
the IPI rates for both locally-produced and imported vehicles that will
now be in effect from January 2015 (instead of from July 2014) and the
discounted rates that were in effect (in brackets) between May 2012 and January
2014.

IPI
Rates on Vehicles in Brazil

Locally produced

Imports

Cars, <1000cc

7% (0%)

37% (30%)

Cars, 1000-2000cc

11% (5.5%)

41% (35.5%)

(alcohol and flex fuel)

Cars, 1000—2000cc

13% (6.5%)

43% (36.5%)

(petrol)

Light commercial vehicles

4% (1%)

34% (31%)

Source: Euromonitor International

With the
increased IPI rate that was intended from July being postponed until
January 2015, the second half of 2014 will be stronger than the first half in
volume terms but is still expected to be weaker in year-on-year
percentage change terms. In fact, sales data released by ANFAVEA for September
reveal that demand was 11.7 percent lower in Q3 2014 than in 2013
and sales are projected to be 10.8 percent lower in the second half of
2014 than in the July to December period of 2013. Accordingly, only 3.25
million new light vehicles will be registered in 2014 – 9.1 percent down on
2013 and the lowest annual level since 2009. However, underpinned by a
recovering economy and healthy growth in the number of Brazilian households
with sufficient disposable income to buy a new car, the outlook is far more
positive. Even with the original IPI rate to be reinstated from
January 2015, 3 percent more registrations are projected for 2015 and further
gains are even expected to take demand to a new record in 2017. In the longer
term, demand is forecast to continue to climb, with the Brazilian market
exceeding 5 million units from the mid-2020s.

Attracted
by the potential, premium carmakers are finally investing in Brazil.

Despite this positive
backdrop, the IPI and duties imposed on imports mean premium cars are not
competitively priced and hence why their share of the market peaked at just 1.5
percent in 2011 before contracting to 1.1 percent in 2012 following the hike in
import taxes in order to protect the domestic industry. Even with the reduced
IPI rate for imports in effect since May 2012, premium brands still only
accounted for 1.4 percent of light vehicle sales in 2013. This therefore
explains why, even at their peak in 2011, premium brand light vehicle sales
equated to just 1.2 percent of the number of households with annual disposable
income over US$55,000. To put this into perspective, however, premium car sales
consistently equate to more than 10 percent of the number of these households
in South Africa and China.

Euromonitor
International forecasts that there will be over 10 million such homes in Brazil
in 2025; twice as many as in 2013 (and about half the number forecast for
Germany). This suggests that premium
players could be on track to import 100,000 light vehicles into Brazil in 2025
anyway but domestic production would create a more level playing field in terms
of car prices, naturally boosting demand for locally-sourced models over
imports.

Households with Annual
Disposable Income Over US$55,000 (Constant) in Brazil, India and Germany
1990-2030

Source: Euromonitor International

A noteworthy comparison is that demand for premium cars grew more
than tenfold over the period from 2006 to 2012 in India, underpinned by just a
50 percent expansion of the number of sufficiently affluent households in the
country. This is fundamentally because of the investment in local assembly in
India by car companies such as BMW, Audi and Mercedes in order to circumvent
high import duties and thus serves as a positive indicator for the potential in
Brazil. In fact, there have always been twice as many affluent households in
Brazil as in India, which begs the question as to why investments by the
premium carmakers have been far more forthcoming in India than in Brazil.
Nevertheless, BMW, Mercedes, Audi and Jaguar Land Rover are all finally looking
to invest in local assembly in Brazil in order to be able to bring their car
prices down to competitive levels and thus tap into the long-term market
potential. BMW kicked off proceedings by producing its first car in its
Araquari facility on September 30, in which the company invested R$600 million
(approximatelyUS$250 million).
Production capacity is reported to climb to 32,000 units per annum (about as
many vehicles as all premium players combined sold in Brazil in 2010) with a
workforce of 1300 employees - some of which will inevitably boost premium
demand for cars in Brazil themselves.